SAN FRANCISCO, CA - MARCH 07: Apple CEO Tim Cook speaks during an Apple product launch event at... [+]
Apple (AAPL) was the most widely held stock among hedge funds and mutual funds in the second quarter. So its stock price determines the compensation packages of money managers big and small. But after losing 24% of its value since its September 2012 high of $705, the question for investors is: Where does Apple stock go from here? Nobody knows -- but it's not for a lack of precise estimates.
Before getting into those estimates, it's worth pointing out that Apple CEO Tim Cook is clearly in panic mode. After staying out of the media limelight for a year, he's decided to do some high profile interviews with BloombergBusinessWeek and RockCenter.
Unfortunately for investors, there is nothing coming out of those interviews to comfort them. After all, Apple stock trades with the same logic as those perennial brayers about debt, deficits, and the apocalypse.
You'll remember them as the ones who kept telling us that interest rates were on the verge of spiking out of control leading to a collapse of the global economy. Or at the very least, the world was poised to end -- the Mayan calendar gives us two weeks. Are you ready?
What -- you may ask -- does this have to do with Apple? Apple trades at a Price/Earnings (P/E) ratio of 12.4 -- that despite the fact that it has been reporting earnings per share (EPS) growth of 57% for the last five years and is expected to boost earnings 21% on average for the next five.
The only logic for this low P/E -- one theory is that the P/E should equal expected earnings growth -- is that a collapse in Apple's earnings is just around the corner. It's just that we never get to that corner -- sort of like the debt and deficit doomsayers. After all, since the U.S.'s debt rating was downgraded in August 2011, interest rates on the 10-year government bond have plunged from over 3% to 1.6%.
This leads us to the question of what Apple is really worth. Nobody knows -- yet there are plenty of theories.
Regrettably -- there are no rules for valuing stocks that actually have predictive value. Although one thing that's obvious is that we live in a beat-and-raise market. This means that a stock will go up if it beats quarterly revenue and earnings targets and raises its forecast. If a company misses on any of these dimensions, its stock price plunges.
The only sure-fire way to win at this game is to trade ahead of inside information about a company's earnings report. That's a plausible explanation for why so many of SAC Capital's former employees are in legal hot water after evidence emerged that they made big money on inside information. The most recently announced example was SAC Capital's $276 million gain allegedly made by trading on inside information about bad results of testing a drug under development.
But despite its questionable predictive value, the game of setting price targets is a lucrative one for Wall Street because it makes people want to trade -- boosting commission revenue. Price targets take advantage of confirmation bias -- people grab information that confirms what they already believe.
Apple bulls, for example, will be happy to buy when they see a price target of $1,160. While Apple bears will trade to profit from the $420 handle.
The theory underlying that $420 target is called technical analysis -- predicting a stock's price based on the trajectory of trading volume in a security. If a stock is going down on heavier than normal volume, this means it will keep falling until it reaches a point of equilibrium. And if it is rising on higher than normal volume, it will keep rising until it levels off.
John Mendelson, ISI technical analyst, told CNBC Thursday that high volume on down days means Apple has 20% lower to go. According to Mendelson "Along with the two volume 'spikes' cited in my Nov. 16 note, [Wednesday] was another volume 'spike' day on the downside suggesting that the $528 support area will in fact be decisively broken on a closing basis over the near-term. My view continues to be that because the stock ran up so fast last spring, the next significant support area is $420."
On the other extreme, you have the $1,160 Apple price target from SeekingAlpha. To get there, the analyst simply made up some numbers -- a P/E and an EPS forecast. In this case, the P/E he used for fiscal year 2015 was 14.5 and his EPS forecast was $80 -- multiply the two together and voila: Apple is worth $1,160 a share.
So what should you do with your Apple stock? If you believe Mendelson, sell it short. If SeekingAlpha fits your bias, load up your apple cart with Apple shares.
My hunch is that tracking what hedge funds are likely to do is the best guide -- when we look back on the plunge in Apple stock in three months, it may become clear that hedge funds were dumping shares.
Those that will be seen to be liquidating, like Diamondback Capital Management that closed down Thursday "amid heavy withdrawals and an insider-trading investigation," according to CNBC, were big holders of Apple.
And there may be others selling to lock in their gains to boost their year-end bonuses. The question is whether those same investors will turn on their computers in January and decide that Apple is worth $1,160. If they do, the stock could have a great 2013.
